No time for terms of endowment
Autumn Property Survey: Low inflation is turning borrowers back to repa yment mortgages. Clifford German reports
Sunday 01 October 1995
Endowment mortgages have come in for a bashing in recent years. The financial media first cast doubt on the windfall bonuses more or less promised to borrowers who took out endowment policies to repay their mortgages in the 1980s. Commentators pointed out that such profits were heavily dependent on levels of inflation.
Lenders were accused of pushing endowment mortgages to earn commission from the insurance companies that provided the policies, long after the gloss had worn off the endowment's charms. The Building Societies Ombudsman endorsed that criticism in his annual report earlier this year.
The comments are mirrored in the statistics. In the heady days of 1988, when houses sold like hot cakes, 83 per cent of all mortgages sold by building societies were backed by endowment policies, according to the Council of Mortgage Lenders. Since then, the percentage has drifted back, to 72 per cent in 1992 and 62 per cent in 1993. In the first quarter of 1995, it dipped below 60 per cent and in the second quarter was down to 53 per cent. Bank mortgages show a similar trend.
The concept of an endowment policy has not changed. An endowment mortgage consists of a loan on which the borrower pays only interest to the borrower, plus a separate monthly payment to an insurance company for an endowment policy. The insurance company invests the premiums it receives, and the value of the policy grows each year through the addition of a modest annual bonus. When the policy eventually matures, the insurance company adds a terminal bonus, which varies with the success of the investments, and the combined proceeds should be more than enough to pay off the mortgage.
The size of the loan in an endowment mortgage remains constant over its life, and the borrow- er will pay out appreciably more interest than on a repayment mortgage, but this will be partly offset by higher tax relief. Endowment policies also include built-in life assurance to redeem the mortgage if the borrower dies.
The pegging of tax relief to interest on the first pounds 30,000 of a loan and the reduction of tax relief to just 15 per cent of the qualifying interest payable has weakened the attraction of an endowment policy. But the main threat to endowment mortgages has been the fall in inflation, which has sharply reduced the profits that the policy investments can make and means the real value of the loan debt no longer falls as it did in the 1970s and 1980s. Endowment mortgages are also less flexible than repayment mortgages.
The performance of endowment mortgages has certainly deteriorated recently. But policies taken out in the 1970s, which gained from the boom years of their 1980s when they were earning 20 per cent returns a year, have proved good investments. According to Norwich Union, its 25-year endowment policies that matured four years ago paid out 4.4 times the amount needed to redeem the mortgage. Those that matured in 1993 paid out 3.6 times, those maturing this year 2.9 times, and it looks as if those that mature in 1997 will be no worse.
The main worries apply to shorter-term mortgages taken out after the boom was over, which have had a shorter period to grow and a less healthy climate in which to mature. Invest- ment returns were negative in 1991 and 1994.
Ten-year mortgages with Norwich Union that matured four years ago paid out only 1.8 times the amount of the mortgage, two years ago they paid 1.5 times, this year just 1.2 times, and in two years' time it could fall to 1.1 times. The performance of other insurers' policies will vary, but the trend is clear.
Repayment mortgages are the traditional methods of financing home ownership. In the old days when building societies had a virtual monopoly of mortgage business, repayment loans accounted for almost 90 per cent of the business. The initial payments consist mainly of interest, with a small fraction going on capital repayments.
Payments are calculated to stay the same, but the composition changes each year with the interest element diminishing and the capital repayment increasing until the final payment is almost entirely capital. The tax relief also diminishes, but these days it is hardly a great deterrent. It is not surprising that repayment mortgages have made something of a comeback. From a low point of just one in seven mortgages in 1988, they accounted for 30 per cent in the second quarter of 1995, and there is no sign of them hitting a ceiling.
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